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BJ’s Restaurants Inc. (BJRI) – A Compelling Short Opportunity

November 08, 2011 | About:
BJ’s (BJRI) has had an incredible run since the credit crisis in late 2008/early 2009, rising from a low near $8 per share to its current price over $50. While BJ’s offers a compelling value proposition to its customers — providing quality food and service at a reasonable price in an aesthetically pleasing environment — the stock price has increased dramatically above its intrinsic value.

Based on today’s closing price of $52.02, BJ’s currently trades at 49x my estimate of 2011 earnings and an EV/EBITDA multiple of 18.2 as broken down below:

Closing Stock Price 11/8/11 52.02



My 2011 Earnings Estimate 1.06



P/E Ratio 49.1



Equity Value 1,441.16

Cash and Investments 49.378

Enterprise Value 1,391.78



My 2011 Projected EBIT 43.454

Depreciation and Amortization 33.129

EBITDA 76.583



EV/EBITDA Multiple 18.2


Company Profile and History

BJ’s Restaurant first opened in 1978 in Orange County, Calif., centered on bringing the flavor of deep-dish pizza to California. The company BJ’s Restaurant Inc. acquired the BJ’s Restaurant concept in 1995 from its original founders and went public in 1996.

Over the years, BJ’s has expanded from a small service pizzeria to a full-service casual dining restaurant with over 100 menu items ranging from pizza to pasta to salad to additional entrees to desserts.

In 1996, BJ’s introduced its own handcrafted beers through its first Restaurant and Brewery in Brea, Calif. Within the last 10 years, BJ’s has expanded this concept nationwide and now runs over 100 restaurants. BJ’s signature deep-dish pizza and handcrafted beers have attracted customers and helped provide significant revenue and same-store sales growth.

BJ’s “casual-plus” restaurant concept seeks to provide a similar dining experience to “upscale casual” competitors such as Cheesecake Factory in terms of food quality, décor, and customer service, but at a lower cost.

As of last year, BJ’s average check per customer was $12.50 while Cheesecake Factory’s average check per customer as of the beginning of this year was significantly higher at $19.00. The checks at more casual restaurants such as Panera and higher quality fast food chains such as Chipotle were not much less, clocking in at approximately $9-10 per person. Below are approximate numbers from each restaurant from data collected within the last 18 months:



Restaurant


Avg. check per customer


Source


Panera Bread


$8.50


qsrmagazine.com


Chipotle Mexican Grill


$11.00


dailyfinance.com


BJ's Restaurant


$12.50


LA Times


Cheesecake Factory


$19.00


nyjobsource.com


PF Changs


$20.00


SEC Filings


Past Financial Results and Customer Reviews



Below BJ’s strong revenue and same store sales growth through the recession is shown as well as improving operating margins and EPS:



2008


2009


2010


2011e


Sales


374076


426707


513860


610144


Restaurants (End of Year)


82


92


102


115


Restaurants (Beg of Year)


67


82


92


102


Sales per Restaurant (Weighted Average)


5021


4905


5298


5623


Growth Rate


-2.3%


8.0%


6.2%






2008


2009


2010


2011e


EBIT


10905


19702


30154


41417


Per Restaurant (Weighted Average)


146


226


311


382


Per Restaurant ex non-recurring expenses


180


226


311


400


Operating Margin


2.9%


4.6%


5.9%


6.8%


Operating Margin ex non-recurring expenses


3.6%


4.6%


5.9%


7.1%


2008


2009


2010


2011e


Net Income


10308


13038


23162


30708


Diluted Shares Outstanding


26749


27147


28167


29093


Earnings per Diluted Share


0.39


0.48


0.82


1.06


The information above is obviously what has analysts and investors excited and proves BJ’s concept is resonating with customers. Total sales, sales per restaurant, operating margins, and net income are all expanding impressively. To arrive at average sales per restaurant, I used a weighted average of number of restaurants at the beginning of the year and at the end of the year. I also examined operating margins without non-recurring expenses related to legal settlements and natural disasters, which gives a true indicator of operating performance.

BJ’s is also in exceptional financial health. As of September 2011, the firm had $49.378 million of cash and investments, no interest bearing debt, and a tangible book value of $314.091 million. Although, as I will discuss below, the firm has significant off-balance sheet operating lease commitments, many of which are longer than 5 years in duration, as well as on-balance sheet "deferred landlord obligations" totaling $44.04 million as of September 2011.

Customer reviews on many sites, such as Yelp and urbanspoon.com, range from average to excellent. On a scale of 1 through 5, the average review is close to 4 stars, which shows the restaurant is resonating with people all over the country. Although specific reviews should be taken with a grain of salt, large sample sizes are often useful. Below are a couple of links with reviews from specific locations:

http://www.urbanspoon.com/r/40/741031/restaurant/Indianapolis/BJs-Restaurant-and-Brewhouse-Greenwood

http://www.yelp.com/biz/bjs-restaurant-and-brewhouse-newark

Now that we have described the positives attributes of BJ’s and what has led to the dramatic rise in the stock price the last three years, lets dive into the negatives and why I believe the stock now presents an attractive short opportunity.

Negatives and Additional Financial Info

While BJ’s food, customer service, and atmosphere have appealed to customers and helped improve total sales, revenues per restaurant, operating margins, and its stock price, the same cannot be said for its free cash flow shown below:



2006-12


2007-12


2008-12


2009-12


2010-12


TTM


Cash Flow from Operations


32


35


59


68


75


85


Capital expenditure


-58


-73


-79


-60


-68


-84


Free cash flow


-26


-37


-21


8


7


1


Source: Morningstar and SEC filings

While operating margins and net income have expanded rapidly, free cash flow is barely positive. This has to do with the high fixed cost to open a new restaurant. On average, BJ’s opens one new location per month, as they have averaged 10-15 openings per year since 2008, and according to their statements and the information provided in their SEC filings, they plan to expand at a similar pace in the future. Below is a link to a recent article discussing expansion plans for 2012:

http://www.globenewswire.com/newsroom/news.html?d=236826


Using information provided by the firm in the company filings, I break down capital expenditures, opening costs, and maintenance capex per restaurant below:



2008


2009


2010


2011e


Capital Expenditures (Total)


83300


60000


73000


84757


New Restaurant Openings


15


10


10


13


Capital Expenditures related to new openings


61700


42300


43800


64857


Carryover from prior year


9100


5000


5000


not spec


Total Cap Ex for New Restaurants


70800


47300


48800


64857


Per New Restaurant


4720


4730


4880


4989


Existing Restaurants Opened


67


82


92


102


Cap Ex Related to Existing Locations


12500


12700


24200


19900


Per Existing Restaurant


187


155


263


195


Restaurant Opening Costs


7384


5327


5189


7345


Per New Restaurant


492


533


519


565




In annual reports prior to 2010, BJ’s not only provided capital expenditures related to new openings and existing locations in the current year, but also an amount related to future openings. In the 2010 annual report the amount related to future openings was not specified.

As shown, the cost to build a new restaurant ranges from $4.7 to $5 million. In addition, the cost to open a new restaurant since 2008 has ranged from $492,000 to $565,000.

If non-recurring expenses related to legal settlements are stripped out, the operating profit per restaurant is about $400,500, based on an estimated EBIT of $43.454 million for 2011 and a weighted average number of restaurants of 108.5. In addition, opening costs should be added back, as I will account for these funds in the cost to open a new restaurant, and I do not want to double count them. In 2011 this equated to an additional $7.345 million or approximately $67,700 per restaurant.

A normalized tax rate for BJ’s is in the high 20s. I assume a 28% tax rate using a normalized 35% U.S. corporate tax rate plus 3% for state taxes minus a 10% FICA tip credit, as according to current law BJ’s can deduct FICA taxes related to employee tips as discussed in more detail below:

http://www.irs.gov/businesses/small/industries/article/0,,id=98463,00.html

NOPAT per restaurant is calculated below:



EBIT 2011e (In Thousands)


41,417


Add back legal settlement


2,037


Add back opening expenses


7,345


Total


50,799


Restaurants beg of year


102


Restaurants end of year


115


EBIT per Restaurant


468.194


Tax Rate


28%


NOPAT per Restaurant


337.099




Using averages from 2008-11 of $4.83 million to build a restaurant and $527,000 in opening costs we see that the return on capital is clearly lower than the cost of capital, assuming the cost of capital is 10%:



(In Thousands)


Average cap ex per new restaurant 2008-11


4830


Average opening costs per new restaurant 2008-11


527


Total costs to open a new restaurant


5357


Average maintenance cap ex


200


Assumed Depreciation


200


FCF per Restaurant


337.1


Return on Capital


6.3%




Now that we have established the return on capital is clearly lower than the cost of capital, we must also consider the fact that operating margins have nearly doubled since 2008, increasing from 3.6% in 2008 to most likely over 7% for 2011. This has mainly been driven by customer traffic and increases in revenue per restaurant as shown above. Given established competitors within the industry, what is BJ’s potential? Below the median operating margins are listed for competitors:



Median Operating Margins of Competitors


Source: Morningstar


Chipotle Mexican Grill


10.0%


Darden Restaurants


9.1%


Panera Bread


10.4%


Cheesecake Factory


7.3%


Buffalo Wild Wings


8.2%


P.F. Chang's China Bistro


5.2%


Average


8.4%




If the numbers are examined further, it is clear that higher quality service, food, and environment equate to lower margins. PF Chang’s and Cheesecake, the two highest quality establishments of the bunch have the lowest margins, while Chipotle and Panera, the two restaurants with the lowest level of service, have the highest margins.

Given that BJ’s is more casual than PF Chang’s and Cheesecake Factory, but much more service-oriented than Chipotle and Panera, their margin potential probably lies somewhere in between.

In my projected earnings model, I assume BJ’s gradually improves its operating margin to the point where it reaches 9.8% by 2016. This equates to $636,000 in EBIT. Adding back restaurant opening costs so they are not doubled counted and adjusting for a 28% tax rate, we still see the return on capital below the cost of capital as shown below:



EBIT 2016e (In Thousands)


107480


Add back opening expenses


6327


Total


113807


Restaurants beg of year


163


Restaurants end of year


175


EBIT per Restaurant


673.413


Tax Rate


28%


NOPAT per Restaurant


484.857






(In Thousands)


Average cap ex per new restaurant 2008-11


4830


Average opening costs per new restaurant 2008-11


527


Total costs to open a new restaurant


5357


Average maintenance cap ex


200


Assumed Depreciation


200


FCF per Restaurant


484.857


Return on Capital


9.1%




Even with expansion of operating margins to nearly 10% and average revenue per restaurant moving above $6.5 million, BJ’s would still not be able to generate enough operating income to exceed its cost of capital. To give you an idea of how costly it is to open a BJ’s, based on an operating margin near 10% as well as using the rest of my assumptions from above and also assuming a 10% discount rate, the net present value of opening a BJ’s would still be negative after 20 years!

Projecting future free cash flows, I value BJ’s at approximately $19 per share, far below its current stock price above $50. My model is shown below:



2011e


2012e


2013e


2014e


2015e


2016e


Sales


610144


700850


793467


891010


993691


1101731


Growth Rate


18.74%


14.87%


13.21%


12.29%


11.52%


10.87%


Restaurants (End of Year)


115


127


139


151


163


175


Restaurants (Beg of Year)


102


115


127


139


151


163


Sales per Restaurant (Weighted Average)


5623


5792


5966


6145


6329


6519


Growth Rate


6.2%


3.0%


3.0%


3.0%


3.0%


3.0%


Cost of Sales


150763


173176


196061


220163


245535


272231


Per Restaurant


1390


1431


1474


1518


1564


1611


Growth Rate


6.9%


3.0%


3.0%


3.0%


3.0%


3.0%


Labor and Benefits


209942


241153


273021


306584


341915


379090


Per Restaurant


1935


1993


2053


2114


2178


2243


Growth Rate


5.3%


3.0%


3.0%


3.0%


3.0%


3.0%


Occupancy and Operating Expenses


125443


142693


159981


177904


196479


215727


Per Restaurant


1156


1179


1203


1227


1251


1276


Growth Rate


2.4%


2.0%


2.0%


2.0%


2.0%


2.0%


General and Administrative Expenses


38787


44508


49411


54408


59500


64688


Per Restaurant


364


368


372


375


379


383


Growth Rate


2.0%


1.0%


1.0%


1.0%


1.0%


1.0%


Depreciation and Amortization


33129


37145


41260


45441


49685


53985


% of Sales


5.4%


5.3%


5.2%


5.1%


5.0%


4.9%


Restaurant Opening Costs


7345


6327


6327


6327


6327


6327


Per New Restaurant


565


527


527


527


527


527


Loss on Disposal of Assets


1281


1402


1587


1782


1987


2203


% of Sales


0.21%


0.20%


0.20%


0.20%


0.20%


0.20%


Natural Disaster Related


0


0


0


0


0


0


Legal Settlements and Terminations


2037


0


0


0


0


0


Total Costs and Expenses


568727


646403


727648


812609


901428


994251


EBIT


41417


54447


65819


78401


92263


107480


Per Restaurant (Weighted Average)


382


450


495


541


588


636


Per Restaurant ex non-recurring expenses


400


450


495


541


588


636


Operating Margin


6.8%


7.8%


8.3%


8.8%


9.3%


9.8%


Operating Margin ex non-recurring expenses


7.1%


7.8%


8.3%


8.8%


9.3%


9.8%


Other Income (Expense)


208


Interest Income


-111


Gain/Loss on Investment Settlement


614


Other (Net)


521


Total Other Income (Expense)


1233


701


793


891


994


1102


Total Income Before Tax


42650


55148


66613


79292


93257


108582


Taxes


11942


15442


18652


22202


26112


30403


Tax Rate


28%


28%


28%


28%


28%


28%


Net Income


30708


39707


47961


57090


67145


78179


Diluted Shares Outstanding


29093


29515


29810


30108


30410


30714


Earnings per Diluted Share


1.06


1.35


1.61


1.90


2.21


2.55


Capital Expenditures (Total)


84757


80945


83344


85742


88141


90540


New Restaurant Openings


13


12


12


12


12


12


Capital Expenditures related to new openings


64857


57957


57957


57957


57957


57957


Carry over from prior year


not spec


not spec


not spec


not spec


not spec


not spec


Total Cap Ex for New Restaurants


64857


57957


57957


57957


57957


57957


Per New Restaurant


4989


4830


4830


4830


4830


4830


Existing Restaurants Opened


102


115


127


139


151


163


Cap Ex Related to Existing Locations


19900


22988


25387


27786


30184


32583


Per Existing Restaurant


195


200


200


200


200


200


Free Cash Flow


-4093


5878


16789


28688


41624


Discounted Free Cash Flow


-3721


4858


12614


19594


25845


Sum of Discounted Free Cash Flows


59190


Discounted Terminal Value


447981


Excess Cash


49378


Total Equity Value


556549


Diluted Shares Outstanding


29223


Equity Value per Share


19.04


Diluted Shares Outstanding as of September 2011

Assumptions: 10% WACC 4% Terminal Growth Rate

Related Parties

According to the most recent quarterly report, it is believed that Jacmar Companies owned approximately 11.5% of outstanding common shares as of Sept. 27, 2011. In addition, according to the most recent proxy statement, James A. Dal Pozzo owned 11.69% of outstanding common shares. Mr. Dal Pozzo is president of the Jacmar Companies. This means Jacmar and its CEO Mr. Dal Pazzo, who is currently on BJ’s board of directors, own in excess of 23% of outstanding shares.

Jacmar, through its affiliation with Distribution Market Advantage (DMA), a national foodservice distribution system, is currently BJ’s largest supplier of food, beverage, paper products and supplies, servicing BJ’s restaurants in California and Nevada, while other DMA system distributors service BJ’s restaurants in all other states. BJ’s believes Jacmar sells products at comparable prices to other vendors as determined by its competitive bidding processes that resulted in three year agreements in July 2006 and again in July in 2009. Through the end of September, Jacmar has supplied BJ’s with nearly $50 million of food and supplies in 2011.

It can never be known for sure, but it is possible Jacmar has leverage over BJ’s in terms of pricing. If I were a long shareholder of BJ’s, I would demand the firm switch to an annual competitive bidding process, or at the very least, check prices of competitors annually and disclose more information to shareholders.

Potential Free Cash Flow Problem

In the latest 10Q, BJ’s states the following on page 20:

“We expect to fund our expected capital expenditures for fiscal 2011 with current cash and investment balances on hand, expected cash flow from operations and expected tenant improvement allowances of approximately $5.6 million.

What are “tenant improvement allowances?”

From Choyce Peterson, a commercial real estate broker:

“Money for space development, commonly referred to as tenant improvement allowances, can serve as key leverage in negotiations with a landlord, either for lease renewal or relocation. In fact, in today’s commercial real estate market, many landlord’s fund 100 percent of building standard (and in some cases above-standard) installations required by tenants.

Tenants who have excellent credit, are willing to sign a longer term lease (seven-to-ten years) or who are larger in size (at least 15,000 square feet) should be able to negotiate having the landlord fund above-standard improvements such as plush carpeting, special lighting or large glass walls.”

Is this a red flag? BJ’s might be relying on negotiating leases or money for improvements and space development to free up cash flow to fund expansion, which according to the definition of "tenant improvement allowances" may result in a longer lease term. Perhaps they should cut back on expansion until their margin and free cash flow improve, and instead, focus mainly on improving traffic to existing locations. This could be a sign of cash flow troubles, which may force a capital raise in the future through issuing additional equity or raising debt, both of which may be harmful to shareholders.

As noted on page 56 of the latest annual report, long-term operating leases have increased substantially. Total operating lease obligations as of Dec. 31, 2010 were approximately $323.5 million, nearly $200 million of which has a duration longer than five years.

Changes/Additions to Auditors Statement

After further research, such as examination of SEC filings of other firms and discussions with CPAs, as well as comments I have received, I am fairly certain the changes and additions to the auditors summary are immaterial.

While I believe BJ’s represents a compelling value proposition to customers -- providing quality food and service in a friendly environment at a reasonable price -- investors are pricing in too much growth and margin improvement into the stock and overlooking some of the red flags present in the financial statements, especially as it relates to the firm’s free cash flow and return on capital. For the reasons mentioned above, I believe there is potential for a solid return over the next few years by entering a short position in BJ’s.

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